Prepared Testimony: Stop-Gap Budget Options Put State on Wrong Path

Below is testimony we prepared for today’s House Revenue Committee hearing explaining why only responsible budget option is for the General Assembly to vote now to maintain current income tax rates for the full fiscal year, rather than once again kicking the can down the road. Unfortunately, the House Revenue Committee did not call the bill to extend current income tax rates.

We strongly believe that members of the General Assembly must stop using irresponsible budget maneuvers and gimmicks that do not solve our underlying budget problems. With roughly $5 billion in unpaid bills, Illinois cannot afford to go backwards once again.

Here is our testimony, as prepared:

The consequences of failing to maintain stable revenue for fiscal year 2015 have been well documented. Indeed, just last Friday, the House overwhelmingly rejected deep cuts to essential services and programs for next fiscal year that would be necessitated by the massive loss of revenue associated with the January 1, 2015 expiration of current income tax rates. We welcome the recognition that such deep cuts would cause enormous harm to our state, gutting investments such as preschool and K-12 education and undermining services ranging from those for homeless youth to veterans who need skilled care in veterans’ homes.

Of course, the House has also not yet extended current income tax rates to raise the revenue necessary to fund the appropriations bills that it passed two weeks ago. What the House has done so far — failing to extend current income tax rates while refusing to make line-item cuts associated with the approaching revenue collapse — suggests the House may attempt some sort of short-term, stop-gap measures to limp through at least the first portion of fiscal year. We strongly believe such maneuvers are harmful and far worse than the most obvious solution: maintain current income tax rates beyond their expiration half way through the fiscal year.

Harm of a Lump-Sum Budget

On several occasions in the past, the General Assembly has literally passed the buck to the Governor by enacting a lump-sum budget. Besides not addressing the underlying problem of insufficient revenue to fund programs and services, doing a lump-sum budget for FY 2015 would shift a perilous amount of risk onto community-based organizations that carry out many state programs and services.

These organizations must plan their budgets for an entire year. Their leadership and boards of directors have a fiduciary responsibility and cannot base their budgets upon a wink-and-a-nod from lawmakers who may want to convey that they will vote to maintain revenue later. Instead, the heads of organizations and their boards must base their budgets on the reduced amount of funds they are likely to receive for the entire fiscal year. The result would be cuts to services, staff, and other expenses. Some providers, already on the edge from previous cuts and bills the state has not paid, may shut their doors.

And, even if the General Assembly were to come back later in the year to maintain current income tax rates, great damage would already have been done. Community-based organizations cannot simply resurrect what has been destroyed if the General Assembly passes a supplemental and claims everything is now whole.

Harm of a Six-Month Budget

Another harmful possibility is that the General Assembly would pass a six-month budget, based on “full” revenue during the first six months of the fiscal year before the expiration of the current income tax rates. While this might sound reasonable, the consequences would still be severe. This creates great uncertainty and risk for organizations that help carry out state services. If current income tax rates were not maintained beyond January 1, 2015, the necessary cuts in the second half of FY 2015 would be much more concentrated. Using a simplified example for illustration, with a revenue loss of about $2 billion spread out equally over 12 months, the per-month cut would be $167 million. However, if the same cut had to be concentrated in the last six months of the fiscal year, the cuts would be double, $333 million, a month.

In some ways, a six-month budget is even worse for community-based organizations, which still need to be able to plan for an entire year. These organizations would have to base their budgeting on the worst-case scenario, but have no idea exactly what that worst-case scenario might be given that they would need to wait until the second half of the fiscal year to learn how cuts would be allocated.

Harm of Using One-Time Maneuvers to Get through FY 2015

The size of the revenue loss — about $2 billion — associated with failure to maintain current income tax rates makes it very difficult to fill for one year. There are very few tax expenditures that could be eliminated or other tax changes that could be made to fill such a gap. Those tax changes that could fill such a gap (e.g., eliminating the exemption of retirement income from state income tax) likely require considerable debate.

We believe that filling a $2 billion hole for fiscal year 2015 would likely require the resurrection of suspect tactics such as unsustainable fund sweeps. Even if the General Assembly were able to paper over the loss of about $2 billion in revenue in FY2015, the revenue losses associated with failure to extent current rates would be more than double in FY 2016 — roughly $5 billion. No amount of gimmicks or loophole closures would be able to cover such a gap in perpetuity.

Uncertainty Harms Illinois’ Economy

Prior to the 2011 income tax increase, Illinois’ spending was average among states while taxation was below average.[1] During that period, Illinois hid this mismatch with various budgetary gimmicks and outright irresponsible practices, such as simply not making annual payments to pension funds. The Great Recession finally brought the day of reckoning.

In combination with deep budget cuts, the General Assembly took a major step to close the long-standing mismatch between its average spending and below-average taxation by increasing the personal and corporate income tax rates in January 2011. However, the General Assembly coupled this responsible decision with the irresponsible decision to make the increases temporary. Even after the increases, in 2012, state spending as a percentage of personal income ranked in the bottom third of states (37th) and state taxation ranked in the middle of states (22nd).[2]

While Illinois has made substantial progress digging out of its fiscal hole, it is clear that with roughly $5 billion in unpaid bills we are not there yet. In the meantime, the state’s remaining unpaid bills, worst-in-the-nation credit ratings, and uncertainty about the political commitment to pay for prior spending has taken a toll on the economy. Over and over again, credit rating agencies have warned of additional downgrades if current income tax rates are not maintained. Simply kicking the can down the road again will do nothing to inspire confidence or to improve our state’s bottom-dwelling reputation.

Given that new research convincingly demonstrates the link between policy uncertainty and economic harm[3], it is clear that this new round of economic uncertainty is bad for our state.

Members of the General Assembly need to ask themselves what sets Illinois apart that might explain our poor economy. Is it supposedly high taxes? Taxes as a percentage of personal income are higher in Wisconsin, Minnesota, Kentucky, and Arkansas (just to name a few). Or is it our state’s poor finances, worst-in-the-nation credit ratings, and reputation for kicking the can down the road?

Now is the time for the General Assembly to make the right decision, not after November when more damage will have been done.

[3] For more on this research by Scott Baker (Stanford University), Nicholas Bloom (Standford University), and Steven Davis (University of Chicago Booth School of Business) visit www.policyuncertainty.com/research.html.